advice from a fake consultant

Friday, February 29, 2008

We are forever being reminded that Americans need to know more about our neighbors around the world...and if you’re reading this, we already know you understand the value of seeking out new perspectives—and that reading the work of bloggers is an excellent way to acquire new knowledge.

If you put all that together, it appears that the missing link in the process of learning more about other countries might just be the lack of a finger to point out some quality bloggers who are able to provide some of the insight we seek (and if any of my Middle Eastern friends are around I’ll point an outstretched hand, instead of the finger, just to be polite...).

Those of you who have graced my personal blog with your presence might have noticed the invitation to “visit the Blogpower community” over there on the left-hand margin; and that’s where we will find everything we need to make this world tour happen.

We’ll also discuss a few recent items of world knowledge that have come to my attention thanks to the work of my communal friends...and then: a shameful admission of my own blissful ignorance.

Put it all together, and a good time should be had by all.

Since this is at heart a tour, our first two stops are to places where our guides are not especially political, but instead lifestyle observers.

Which leads to our first story.

You may not know it, but if you live in Sicily there’s a strong probability that your house is not connected to a water distribution system. Sicilians instead rely on water trucks to deliver water to the cistern that serves your residence. There are many who live in villas with other families, which means you and your neighbors share water.

And occasionally, you run out.

And because it’s Sicily, getting the water is a story all its own. There are public water trucks and private water trucks...and waiting lists...and days the water “isn’t being delivered”.

All this and more I’ve learned thanks to a transplanted teacher from Wales who is now publishing Sicily Scene. Even better, "Welshcakes Limoncello" spends lots of her time in fantastic little cafés, takes the time to show us pictures of what they’re serving...and really offers a feel of what it is to be her neighbor.

If we grab a fez, jump across the Mediterranean, and hang a quick right over to the west coast of Africa we’ll be in Rabat, Morocco; which is where Lady MacLeod’s truly delightful “Braveheart Does The Maghreb” walks us through souks, talks about the role of the woman in an Islamic society (a theme to which we will return at the end of the discussion), adds an occasional dose of cultural intrigue...and even romance.

Another transplant—this time a Scot who has “expatriated" her way across Europe, South Asia, North America...and now, with her daughter, Africa; and who apparently is riding a pretty good lucky streak.

She told a tale a few months back of making a date for dinner...but the date was not at a restaurant.

She reports instead that she was taken by her beau to the beach, where a traditional Bedouin tent had been erected. She tells us of the night, and the fires, and the music...and the scented breeze coming through the tent on the balmy Moroccan night.

There are struggles for autonomy throughout the world—including just “across the pond” in the UK. Cornwall is seeking to find their unique niche in this picture, making “The Cornish Democrat” essential visiting.

The Duchy of Cornwall is located in the far southwest corner of England (the English Los Angeles it’s not, just in case the question came up...); and there are those who argue the case that Cornwall’s accession into the UK was involuntary. They further argue that the Duke of Cornwall seems to be the current legal Sovereign, or in the alternative that the People of Cornwall are the legal holders of power.

If proponents have their way the status of Cornwall might resemble that of Ireland, Scotland...or maybe even the Isle of Man.

Were you aware that the UK is debating whether or not to require compulsory education for 17 and 18 year olds? It’s a fact: at the moment many leave school at the age of 16 to enter the workforce. As you might imagine, the debate centers around issues of cost and competitive position in the world marketplace...and strangely enough, the Conservative party does not support the initiative, and the Liberals do.

And then there’s the parking story.

Health care is provided by the UK Government to the citizens, and the National Health Service is perennially short of funds. Premiums and co-pays are theoretically out of bounds...which apparently means the “employee of the month” award goes to the one who is most creative at inventing new revenue streams...which is why the UK government booked nearly $200 million last year (minus the cost of the framed “employee of the month” photo and the little brass plaque) by charging patients to park at NHS facilities.

Call it a tax, call it a co-pay (for the benefit of our UK friends, a co-pay is what insurance companies make us pay for our health care at the time of the doctor’s visit--and it can be up to 50% of the cost of care)....either way it’s a new expense that’s making UK citizens sick—of the NHS.

Mike Ion brings that and more—including discussions of the problems students encounter with school assignments, questions about liberation theology, and an interesting take on the UK voting age...and that’s just in the last week.

Our final guide will show us what life is like for an Islamic woman living in the Sudan.

One of the very first stories I ever read from Kizzie was a conversation about the stratification of status among those who wear the burka or abiya. It was astonishing for me to discover that women who are not veiled often look down on those who do; that they see them as “country bumpkins” who are unable to make their own decisions.

But this is the part of the story where I have to admit my own foolish behavior.

Just a few days ago I was visiting Kizzie’s blog, and she had a few questions about our esteemed President. To make a long story short, the basic thrust of the interrogation was related to Mr. Bush’s lack of understanding about the region.

Always trying to be helpful, I sent a long comment to Kizzie remarking that the ignorance problem she cites is not just Mr. Bush’s, but all of ours. And then I got stupid. I went on to comment that Mr. Bush probably knows very little about Kizzie’s country beyond what he saw in “Blackhawk Down”.

And then I sent the comment away.

And then I re-read what I had written...which meant that I had to quickly write another comment pointing out my own foolishness, and suggesting that my foible is exactly the sort of ignorance that often drives America’s foreign policy mistakes.

“Sudan...Somalia...what’s the difference?” is exactly the sort of dimnitude that has made “The Ugly American” a worldwide joke, and your friendly fake consultant apologizes to Kizzie and all her Sudanese friends for my foolish remark.

But it does reinforce the point.

We, as Americans, need to take the time to learn something about all the world...and if we do, our efforts at foreign policy might get a bit easier, fewer of the world’s citizens might see Americans as targets...and we might even make some new friends along the way.

Not to mention knowing in advance which of Sicily’s cafés offer the best desserts.

Monday, February 18, 2008

There will be a great debate as November approaches over who is a “fiscal conservative” and who is a “tax and spend liberal”.

It is highly likely someone will throw the words “transcendent challenge” into the conversation, and that got me to thinking…what if there were other “transcendent challenges” besides “islamo-facism-scary-monster-gonna-get-us”?

Then my thoughts went further (always a dangerous step), and I found myself asking: if we hadn’t of spent that $2.4 trillion on one transcendent challenge, what else could we have done with the money?

Some of today’s answers are serious, some are maddening, some are silly…and all of it is our tax dollars in action. (Well, to be fair, it’s not all ours. Our kids and grandkids will be chipping in, too.)

Before we start, a warning: don’t believe that $2.4 trillion will be the end of it.

Remember, we still need to replace or “trade up” virtually all our now worn out military rolling stock (maybe $300 billion or so), and there are aircraft to replace as well (adding about $500 billion more to the cost); making my “back of the envelope” guess an additional $800 billion for the two…meaning we’re really looking at some total number in the $3.2 trillion range--even if we came home right this very minute.

So, what else could the money have bought?

Well…who thinks education is important?

For the same $2.4 trillion we’ve spent so far on the war we could have given a $25,000 educational grant to 96 million Americans.

Who among us has entered the Publisher’s Clearing House Sweepstakes?

The Prize Patrol would need to hire some help, but you could afford it—because even if you gave 2 million people $1 million each, you’d still have $400 billion left over for payroll.

Ever been to Vegas?

You could not lose this much money if you tried. I figured it out—if you lost $10 million every day for the rest of your life…well, to lose this much you’re going to have to figure out how to live 657 years. Of course, with $2.4 trillion, you might.

Speaking of which…they tell me if you buy in bulk you get big discounts. Well, if you decided to buy everyone’s health insurance, you could pay a $500 monthly premium for 300 million Americans for a year—and still have $600 billion in your pants pocket to go back to Vegas with. (This, by the way, is about enough to buy the entire place…lock, stock, and “gentleman’s clubs”. And you might as well. After all, you’ll be there 657 years.)

Wanna buy something else in bulk? With that kind of money, you can shop at the “corporate Costco”…so let’s really think “supersize”:

Let’s grab something from the Halliburton aisle…and maybe an Exxon/Mobil, too…and a GM, and why not a Starbucks while we’re at it? Toss in a Nike, and how about we grab Costco, too.

The total market capitalization of all of them put together?

Not even $500 billion.

Fort Knox? You could buy 18 of them, based on the current estimate of US gold holdings at the site and a $900 per ounce price of gold.

Or you could buy 4.8 trillion Jack-in-the-Box tacos. (By the way, if you ate two of those daily it would take about half the estimated history of the universe to finish them all-more than 6.5 billion years.)

That $350 iPod? You could give one to just about every human on the planet…and some download cards to go with them. Think of it as hooking up 6 billion of your closest friends. You, for all intents and purposes, would be Santa for a year.

Just for the sake of argument, let’s say that 100,000 Americans will be sleeping in their cars tonight. You could buy those 100,000 people 365 Cadillac Escalades (at $50,000 each…again, bulk discount), so they could sleep in a different one every night--and it would still leave you with more than $500 billion to play with.

You could take everyone in the US to the Old Country Buffet—a thousand times.

Spring training is starting. You’ll want good seats…why not buy 30 teams a $500 million Arizona or Florida training facility? And why not do it again every year for 160 years? After all, you can afford it.

Why not go really nuts? Take the team out for a movie after practice.

For $2.4 trillion, you could have bought 9 movie tickets, 9 large tubs of movie popcorn and 9 large drinks—and you’d still have had $1.63 in change left over.

I once proposed in these pages that we convert surplus aircraft carriers into “Peace Ships” with hospital and other emergency supplies for use during disasters worldwide. At $3.5 billion each we could buy a fleet of 685.

If you split the $2.4 trillion evenly, you could be as rich as Bill Gates ($50 billion, more or less)—and so could 47 of your friends.

In the wake of Katrina, the Army Corps of Engineers is spending about $25 million to build a mile of levee. Instead of flooding Iraq with US troops, we could have bought 96,000 miles of flood control. (If we built just a bit less we could afford the $50 billion it would cost to build each of 250,000 Louisiana residents a $150,000 house…and $50,000 worth of stuff to go in it.)

Who in this group is a golfer? How about $150 green fees, $100 cart rental, $100 for lunch and cocktails…every day for 18 million years. (If you pay the same for your other 3 deadbeat friends you can only go every day for 4.6 million years; but that’s the price of friendship, I suppose.)

Does art grab your fancy? Maybe a nice $150 million Van Gogh to spruce up each of the empty looking walls around the old mansion? You better have 16,000 empty walls…you’ll need ‘em.

Would you like to buy the world a Coke? At $1.00 each, you could—every day for a year, with money left over.

Or instead, shoes? There’s money in the budget for 24 billion pair at $100 each-that’s roughly 3 pair and a left foot for every person alive today.

So what’s the bigger point here?

It’s simple.

As we mentioned at the top of this story, someone is going to tell us all about what a fiscal conservative he is…at the same time he’s telling us about a “hundred years’ war”.

Well, if you listened to me and spent the money in some of the ways I’ve illustrated here you’d be a damn fool—but you’d have more to show for the $2.4 trillion than what we have today…and we’d probably all feel a lot safer, too.

So when the fiscal conservative is peddling his rhetorical wares, let’s be sure to remind him of this conversation…and let’s watch him squirm.

Sunday, February 17, 2008

A substantial amount of work has come from this desk recently that has sought to explain complex economics, change the nature of corporations, offer alternatives to a pointless corporate merger, and recognize a pair of youthful Constitutional heroes.

All of that deep thinking has begun to tax the ol’ melon, however; and in an effort to ensure continued mental harmony and balance we take leave of those subjects for today to discuss, instead, an oddly commercial look at love, a linguistically odd take on caffeine and the English language, and a story that oddly manages to link Valentine’s Day, death, and the commercial inevitability of smoked meat.

To quote Frank Zappa: “Get your shoes and socks on people, it’s right around the corner…”

OK, so we have to start with the Wal-Mart story…because it’s just so “Kathy Griffin”.

For reasons that you’ll all just have to accept, on the evening of the 13th of February The Girlfriend and I found ourselves in a Wal-Mart.

For those who don’t go into those places, I will set the picture. The passage from the front door to the sales floor (which I suppose is a sort of vestibule) is always lined with the items that are to be “pushed” the hardest; and as you enter the sales floor area there are “end cap” displays at the end of the aisles that present you with other assorted exciting “must-haves”.

You might have seen or heard stories of the “midnight madness” sales the day after Thanksgiving, and the entrance of the Wal-Mart on this day had much of that atmosphere as the entire vestibule (on both sides), the end caps of the oncoming aisles, several giant red Valentine’s gift display tables, and a variety of other standing displays all groaned with their romantic offerings.

Dozens of shoppers roamed the displays—so many so that it took me a minute to see what I saw…a sight which left me so strongly affected that I actually had to have my irony meter recalibrated after I got home that night.

What did I see?

Imagine we’re standing near the junction of the vestibule and the sales floor. As we look to the left there are tables covered with plants and balloons next to every cash register line.

The signs scream: “$4.99! Low, Low, Prices!” in a smiley face language of blue and yellow that is blinding to hear...Look to the right and we see shelves seven feet high festooned with stuffed animals of every description…and red, red, red, everywhere.

Just a few degrees to the left of that is the first of the end caps, and up that aisle are tons of shoppers…because that’s the chocolate aisle. Next to that is another aisle of Valentine’s silliness…and it’s all so unbelievably red, with pink fur trim and electronic singing and LED lights…

Right in front of us is the maddest part of the whole thing, the three card aisles…Dads telling the kids what cards to get for Mom…Moms and their daughters crowding around…”Oh, that’s soooo cuuuuute” is being chanted over and over like a mantra belonging to a religion of Saccharine Satanists…

And if you look just a bit farther to the left, in the dead center of the main front aisle of the store, surrounded by all the other vital Valentine’s supplies…and immediately next to the jewelry department…you will see what Wal-Mart apparently felt was the most important Valentine’s Day supply of them all:

From right to left you see red hearts, red hearts, red hearts, red hearts, jewelry, cheap wine…and red hearts.

They had all the good stuff, too: the B&J that comes in that blue box, and the one that has the kind of a berry-colored box--and not just the crappy Gallo, either. They had Gallo magnums. You wanna talk about class, this was it.

Try to imagine if you went to sleep in the normal world, and when you woke up the next day the biggest store in bizarro world had been taken over by “The Jerry Springer Show”…that was exactly the atmosphere; and I swear I was looking around for Todd, in his headset, to lead the audience chants.

By the way, right next to the cards were two DVD displays, including the “Black History Month” video display (yes, Virginia, there is a “Black History Month” video display at Wal-Mart)…which contained two movies I had not previously considered as Valentine’s Day/Black History Month crossover interest films…but then again, I’m probably just not as able to see the big picture as the esteemed corporate marketing executives.

You come home with films like that, you’re guaranteed a very…interesting…Valentine’s Day, indeed.

With that story out of the way, let’s move on…

Starbuck’s no longer rules “upscale” coffee, what with McDonald’s and Dunkin’ Doughnuts having recently entered the business; and the folks at Dunkin’ are today running commercials that are clearly intended to take a shot at the pretentiousness they perceive in the Starbuck’s experience.

The setting is the local coffee shop, where the line of waiting customers are singing in unison about how tough it is to wrap their minds around the strange language they are encountering there…a sort of Frechtalian that features words like Venti, or Doppio, or something of the sort.

The soothing voice of the announcer reassures America that Dunkin’ Doughnuts would never do that to us, delivering a tag line that is destined to become an instant irony classic:

“Delicious lattes from Duncan Doughnuts. You order them in English.”

Rumors are that they plan to branch out into additional new menu items; meaning it will soon be possible to order other great American classics (like arroz con pollo, croissants, and Sauerbraten) in English as well.

Because after all, no real American wants to be forced to order a latte in French.

And finally, a story that, as promised, manages to ironically mix a holiday and smoked meat.

The Valentine’s Day edition of “Oddball” featured the porcine redux of the famous “Heart Puppy”…the cutest little baby piggie you ever saw, with a perfect tiny black heart on the side of his snow-white hide…and just to get it out of the way, let’s all say it together…

…”AAAWWWWwwwwwww…”

Before you spontaneously erupt into treacle, however, you should know there’s a dark future ahead for our little Wilbur.

The farmer who is raising the minute bit of livestock reports that the heart is actually considered to be a genetic indicator…and I swear I am not making this up…of…again, I’m sorry to have to be the messenger here…particularly delicious meat.

That’s right, in the most awful bit of Valentine’s Day irony since the Massacre, our little Heart Piggie faces the prospect of becoming…Heart Bacon.

So there you go, my friends: we have cleared the desk…if not the brain…and we are ready to move ahead with more serious stories; our harmony and balance a bit more restored.

And as for me, I’m in the mood for a bit of a “pick-me-up”.I think I’m gonna head on over to the Dunkin’ Doughnuts and try that new English language coffee drink we were talking about earlier: the “Freedom Latte”.

Saturday, February 16, 2008

For the past couple of years Microsoft has pursued Yahoo!; and over the past week the news has been full of discussion regarding Microsoft’s (now rejected) $44 billion takeover offer. Rumors suggest Yahoo! might seek as much as $56 billion.

The company that put Bill Gates on the map reports that the intent of merging the two is to create an online community and search service that could rival Google, and to develop new services that will turn that online community into a new form of online cash register down the road.

As a fake consultant, it’s my real fake job to offer advice on these sorts of deals; and since Microsoft’s CEO, Steve Ballmer, does not appear to have been well served by his “real” consultants, today’s discussion is, literally, advice from a fake consultant.

To understand the logic of the deal, we need to understand exactly what Yahoo! does for a living—and the most important thing they do is “host” an online community of millions (Yahoo! Groups) in the US. They also own a major e-mail service, the HotJobs website, and are trying to establish an open-source competitor to the Windows Mobile operating system for your phone or Blackberry-like device.

The reason internet communities are important is because they are one of the most effective ways to gather potential online customers in one place…which allows the owner to gather advertisers to the same place. It also becomes possible to establish online “shopping malls” (think of eBay and their Power Sellers); and just as in the terrestrial world, it’s possible to charge “virtual rent” for the online space. (You can also make great money processing the online payments, which is why eBay paid so handsomely for PayPal.)

Another way to gather customers is to provide an ubiquitous search service that everyone wants to use…in other words, Google. If billions of “eyes” are on your site daily doing searches, you really have something to sell to advertisers, and Google is the world leader in that market.

If you’re really smart (and Google is), you keep records of where your visitors go and use that data to develop a process to deliver advertising to visitors that will be tailored to what interests each of those visitors. Then you buy the largest online advertising agency (AdSense). Then you convince the owners of millions upon millions of websites to let you place your advertising on their sites, and you use your process to decide which ads go where.

Yahoo! has a search service, but Google’s is immensely more popular. Microsoft owns the MSN internet service, which also operates a search service and some online community features, but the two combined do not begin to approach the popularity of Google.

One of the most memorable characters from the film was Genesee County, Michigan’s Sheriff’s Deputy Fred Ross, who was charged with the task of performing evictions in a county that was losing thousands of GM jobs at a time—over 30,000 lost in the County’s largest city, Flint, by the time of the film’s 1989 release.

He posed a question (and an answer) that is as relevant in this instance as it was in the film. To paraphrase: “What’s the point of a woman marrying someone else who’s already broke? She can be broke by herself—and do it for less money.”

Now we get to the advice part.

If Microsoft doesn’t marry Yahoo!, what are they to do to finally grow the internet business they have never really seemed to be able to get off the ground?

A business that can challenge Google…especially in China.

Here’s a radical thought: instead of spending $56 billion on someone else’s shareholder equity, why not invest a similar amount internally and make MSN into the world’s coolest place to be?

Since China is the market of the future, let’s start our investment program right there.

Why not create a new Chinese television show, not unlike a melding of “The Apprentice” and “American Idol”, offering a big prize…say, $50 million…for the best internet business idea? See if Bill Gates will be a judge alongside a famous Chinese business personality…or the iconic character who awards the cash to the winner.

“China’s Next Mega-Millionaire…sponsored by MSN”.

In parallel with the show you create the MSN community that runs the voting, the contestant video audition upload service (online viewers vote for these, too…keeping eyeballs on the site 24/7), hosts all the chat and gossip and “news” and daily voting results that you can pump out, and sells the merchandise generated…and you get to deliver advertising to billions of eyeballs week after week…on TV, through personal appearance tours, and on the Web.

Of course, the recent announcement that all mobile phone carriers except Nokia now offer Windows Mobile-enabled devices means you can port all this content to even more eyeballs by phone.

All of this could easily be done for under $1 billion…including marketing, and the odds and incidentals that might be needed to get it going. We also assume a few well-placed “licensing fees” will assist the process, and expect the cost on that to be manageable as well.

Naturally, the second part of the prize is MSN operating the business in conjunction with the new “Mega-Millionaire”…and the ongoing relationship with the Chinese public is further reinforced.

And then you do it all over again. And again. And again.

The payoff from being China’s coolest ongoing “product release” party?You’re gonna need extra staff to count all the money.

But I’m not done yet.

Want to quickly make MSN “the” world’s coolest site to visit?

Free, legal music downloads.That’s right…any song you could ever want, from anywhere in the world musicians can be found, free.

Offer each of the major recording library owners some absurd amount of money on an annual basis ($500 million each, guaranteed, upfront, nonexclusive?), in exchange for the distribution rights to the libraries. Offer to distribute new music for new artists, as iTunes does today…and pay those unsigned artists based on how many free downloads MSN customers request. This makes MSNZune the most desirable site from the artists’ and customers’ perspective—and knocks iTunes down to size in a big hurry.

It’s a win for the library owners as well—free and legal makes pirating pointless…and it creates opportunities for distribution of desired media in limited packaging for premium prices.

The total annual cost: this could be done for under $5 billion annually…and it should be possible to recover that cost in the form of advertising revenue as you grow the site. Even if you take 3 years of no revenue at all, the cost is below $15 billion—and you can sell Zune players and tons of artist-related products at the same time.

By the way, if you want to monetize music…has anyone at Microsoft ever considered making an offer for LiveNation? There’s a synergistic brand, not yet fully developed, that could be leveraged off all the other ideas we just discussed. The immaturity of the brand means it could be purchased with far more “bang for the buck” than Yahoo!, with a real growth potential for the future.

Think MSNXBOX. In addition to the XBOX Live service, you add “meet the developers” chats and interaction (watch the G4 channel and then either buy them out or do it better)…MSNTESTCORPS for beta testers and others (more viral marketing potential and a “testbed” for new game concept discovery); and the MSNToolshed, for those who want to build out their own versions of the games (an apprenticeship program? an international “unknown talent” hiring hall? an ongoing focus group? all of the above? you bet).

MSNFREEGAMES does just what it sounds like: it provides free (ad supported) games to XBOX, PC, and cell phone users alike…and contests like crazy. $50 million in giveaways annually, distributed worldwide? That’s peanuts compared to $56 billion…and it grows property you already own that’s already demonstrated it can be of interest to the gaming public…and again, you don’t have to enrich someone else’s stockholders to do it.

And of course, MSNZune, the Zune device itself, and the XBOX complex all gain presence at future MSNLiveNation events…and giant MSN “tour tents”, swag giveaways…and “meet the musician”, “meet the game character”, and product release events become more and more melded together from then on.

Even more so with the release of “Rock Band”, which seems to be the vehicle by which all of this might be realized…especially as new bands are added to the game…creating the demand for “add-on” versions that let you be the band you love the best…and naturally you’re willing to pay MSNLiveNation fat money to get tickets to the show when that same band comes to town.

This means MSN suddenly becomes the means by which you can sell Zunes, XBOX, games, and concert tickets…and a place that gathers the participants in all of those communities for a world of hungry advertisers.

Here’s another idea: develop an online music creation service that gives XBOX owners and PC owners (and you too, Apple and Linux!) free tools that allow them to make music and video, along with online musician and fan communities and artist collaboration tools that let artists meet, link up, and build an audience at the site…which means MSNArtistBuilder could quickly become another of the most important gathering places on the ‘Net….with the output of artists who work over the service ported to the MSNZune service, as we described above…not to mention the potential “Rock Band” tie-ins.

How to promote it?

How about the first “Planetary Battle of The Bands”, with videos and voting from the site, by XBOX Live or computer or cell phone, with a $10 million prize for the winners to guarantee some serious worldwide media attention? And then do it again every six months.

Ka-ching!

We still haven’t really discussed what might be done with MSNSearch, but here’s an idea no one else has today: why not spend some R&D money to develop a “media hunter” engine that allows users to hum a tune which the service uses to locate the song? Then expand the idea into a tool for searching video

Universal media search that’s better than anyone else’s: an advantage that should be worth quite a bit, and if it costs $1 billion; or even $5 billion…compared to $56 billion, so what?

Spend the extra money to make this useable in every language you can find...in other words, as far as the competition is concerned, hit ‘em where they ain’t.

Now even if you go nutty with the money, there’s no way all of this could possibly cost over $40 billion (and don’t be afraid, Mr. Ballmer, to send me a lil’ taste of that delicious Redmond Cheddar if all this strikes a responsive chord); and we haven’t even come to the part where Microsoft might be able to truly realize their fondest dream…the part where they stop selling so much software—and start renting more of it.

The copy of Windows that came loaded on your computer was purchased by the machine’s builder…but why should Microsoft only make one sale? Why not “rent” maintenance, upgrade, and new product services by the month? This is already underway, and by moving the process to an MSN branded location we lay the groundwork for the inevitable next step: Office Online becomes MSNOffice and that rental process begins.

A version of Office can be developed that allows finished work to be stored and retrieved by the user from their own machines, and the Office program functions are rented for…say…$9.95 a month, which means there’s a huge potential future revenue stream—and it’s one Microsoft has always wanted to access.

The advertising supported version, available for free, offers even more potential for “eyeball gathering” (along with reducing the OpenOffice and piracy threats), and MSNOfficeFree users’ “sessions” would last much longer than the microseconds most users spend looking at pop-ups as they wait for other sites to load today.

Thursday, February 14, 2008

We had a lively discussion last week regarding the causes and possible future of the “subprime crisis” that is on everyone’s lips these days.

Having examined the sources of the problem, and noting the lack of holistic thinking about how things might be resolved, I’ve taken it upon myself to come forward with an idea that can actually get at the root causes of today’s difficulties…and do it in a way that offers a potential “win-win-win” outcome for homeowners, investors—and the taxpayer.

Paying attention, Presidential candidates?

Good—because time is short, and we need to get to work.

For today’s solution to make sense, we, like Sherman and Peabody, need to make use of the “WABAC Machine”. We’ll set the time dial to the late 1980s, and we’ll set the location as the headquarters of the Resolution Trust Corporation.

What we’d find is a governmental organization established at the height of the “savings and loan crisis” of the 1980s. The savings and loan companies had made a series of bad real estate investments (much like today), and many had already entered or were in danger of bankruptcy.

Perhaps not surprisingly, many of the same names we recognize today from the world of politics were also to be found “doing bidness” at the time of the birth of the RTC…and if you look it up, you’ll find such luminaries as John McCain, Barney Frank, and even Neil Bush doing things that they today wish we would forget.

In fact, there were so many people doing things they wish we would forget that the RTC was needed to find buyers for all the bankrupt savings and loans that had piled up across the nation. The way this was accomplished was to use regulatory pressure to politely force the bankrupt to accept offers from the more solvent.

And with the history lesson complete, let’s scoot on back to the “WABAC” machine and return to the present day, shall we?

Those who participated in our bond insurance discussion (and many who didn’t) may recognize that the biggest problem currently affecting the American financial sector (and beyond) is an inability to accurately determine the exact value of various financial assets.

As you may recall, we noted that one form of these assets are “collateralized debt obligations” (CDOs), which are fundamentally income streams from loans backed by real estate collateral. The original debt was incurred in the form of mortgages or equity loans. The current owners of these assets are not the originating lenders; but instead investors scattered across the planet which have purchased bundles of these loans, a process known as “securitization”.

Because there is a disconnect between an investor in Singapore who purchased a CDO and the borrowers back in the USA who are supposed to be making the payments; it is at the moment impossible to determine with any accuracy the actual value of any particular CDO. In other words, if you invested in loans and you don’t know who might fail to pay, how can you know what your investment is worth?

Lenders, regulators, and investors prefer clarity above all else. In a perfect world, borrowers who might be in trouble would promptly contact lenders to initiate a “workout”. Then everybody would know the status of every individual CUSIP, and life would again return to a state of near normality. (CUSIP is a fancy technical term: each individual loan that makes up a CDO is known colloquially as a CUSIP, and has a CUSIP registration number. Other types of debt instruments, such as bonds, also use the CUSIP registration process.)

But how is that supposed to happen when neither the borrower nor the investor know each other?

That’s where this proposal comes in.

Imagine, if you will, a new Resolution Trust Company that would be chartered with the purpose of creating a “clearinghouse” where investors and borrowers could reach accommodation—and where the status of individual CUSIPs could be determined, registered, made known to participating investors, and, in a privacy protected form, to the public at large.

On the investor side, the process would begin with each investor voluntarily “registering” their CDOs with the new RTC. The registration process would determine exactly which CUSIPs are associated with every registered CDO, and this data would be maintained in a public database.

On the borrower side, an advertising campaign that might look like the ads you see for “credit counseling” services would be run by the RTC…something like: “Are you facing foreclosure? We can help to keep you in your home. Call 800 NO FORECLOSE today”.

The RTC would be empowered to act under a limited power of attorney on behalf of the registered investors and would have the authority to negotiate payment arrangements that might include extending the term of the loans at lower payments, some form of delay on “teaser rate” ARM adjustments, or converting the ARM to a fixed-rate loan—or any combination of the above, as warranted.

In extraordinary cases, the RTC could facilitate direct negotiations between homeowners and investors—and in cases where the home is “under water” (the amount owed is greater than the home’s value) such negotiations will be needed.

Every day, as more and more homeowners call in and the status of their loans is determined (“current—no issues”, “default”, “in processing”, “resolution unsuccessful”, “unknown”, and “resolved” are examples of categories to which the loans might be assigned) they can be matched to their registered CUSIP. As the database fills, this creates the clarity that allows more accurate valuation of the CDOs associated with the CUSIPs…which should be the necessary first step in resolving the valuation issue that’s currently choking up the financial markets.

By publicly posting the loan status and the CUSIP number-without other personally identifiable information-it would be possible, to some degree, to protect the homeowner’s personal credit information from public view, while still offering an “open and public” assessment by an independent third party of the CDO to which the CUSIPs are associated…which means private financing can return to the mortgage market with renewed confidence in what they’re buying…which should also have a positive affect on the stock prices of some of the most beaten down companies in today’s market.

At the same time, as the foreclosure rate declines (if this proposal were successful, that could happen rather quickly) less surplus real estate appears on the market…making investment in land and homebuilding once again a reasonable business proposition. Fewer foreclosures also means less decline in the value of affected neighborhoods, which means the neighbors benefit as well.

All of this could be funded by a registration fee per CUSIP (or based on the amount of the loan) charged to the investors that covers the cost of the RTC’s operations.

You might have noticed that I have not referenced what might be the most daunting problem a new RTC might face: the problem of large loans for large projects. How does the $30,000,000 loan to the Florida land developer who has a half-finished condo complex as collateral get worked out?

I have no idea, but it seems to me that the role of the RTC might be best served by doing the high-volume, “cookie-cutter”, single-family home resolutions (and similar duplex, triplex, and other “small unit” properties), leaving the most complex solutions to be negotiated directly between borrower and investor, with loan servicers and bond insurers charged with facilitating resolutions of these problems on their own.

If solutions can’t be found, the bond insurers are on the hook for the income stream, but if the bond insurers default the investors will get nothing (even when they do get paid the cross-ownership is so convoluted that as we move through the process some of the investors will potentially have to work out deals with themselves), so everyone involved should already-or soon will-have what R. Lee Ermey once famously referred to as “the proper motivation”.

So with all that said, what do we have?

We have a proposal that creates a new RTC for the purpose of “clearing” CUSIPs, which allows CDOs associated with those CUSIPs to be valuated, which creates the conditions for private investment to return to the mortgage market.

We do this with the only cost to the taxpayer being limited to incidental costs (registration fees not collectable, and the cost of enacting the legislation, for example) and the burden of bearing the upfront costs of establishing the RTC and launching the ad campaign—which presumably will be recovered as the process moves along to conclusion.

We also do this without changing the “risk profile” of the loan portfolios held by Fannie Mae and Freddie Mac—a potentially huge benefit to the taxpayer.

The investors, bond insurers and loan servicers win because it suddenly becomes possible to credibly and independently valuate the CDOs, communities win if foreclosures return to normal levels, and homeowners get to keep their homes and credit ratings…and the larger economy benefits as the CDO market, for the first time, feels the “cleansing effect of sunshine” brought on by greater disclosure.

And to top it all off, the “moral cost” of the bad choices made are borne by the involved parties, rather than the American taxpayer: homeowners who made bad loan choices still have to pay off the loans, even if it takes longer than they originally thought…investors will lose or have delayed some portion of their interest income…and the best part—investors and “predatory lenders” who foolishly participated in sketchy loans to currently “under water” borrowers will probably lose some or all of the value of those investments as the true state of their CDO portfolio becomes known to the market at large.

Monday, February 11, 2008

It is the central tenet of corporate theology: the maxim that corporations exist for one purpose only...to maximize profits for their shareholders.

We are forever feeling the impact of this “damn the torpedoes, full speed ahead!” kind of thinking; and we are forever wishing that we could do something about it.

Well, what if we could?

Today’s conversation suggests we can...and that we can use the power of the market to “incentivize” (cool corporate buzzword, eh?) the sort of behaviors we seek from corporations—and that we could end up with a stronger economy in the process.

Before we get too far, a disclaimer. This is an admittedly unfinished concept that may contain all sorts of unanticipated consequences, and I encourage all of you to think through this and point me to my errors of thought. That said, here we go:

Under the current theology, the only members of society that corporations have any incentive to consider are the corporate management class itself, shareholders, who have the power to impose discipline on members of the corporate management class, and governmental players, who have the power to give and to take away...and who are often themselves, at various points in their careers, members of the corporate management class—maybe even from your own corporation.

There are no real incentives in the system that encourage corporations to bring workers into the management process, nor is there an incentive for corporations to consider the communities that are affected by corporate mobility—at least, not once the local tax incentive has been collected. There is no incentive for corporations to become environmental advocates, nor champions of “social health”.

To create such incentives, this proposal would create a second class of corporation: a “social conscience” corporation, which would maintain its beneficial tax treatment and enhanced legal status based on the attainment of certain social goals.

Corporations could voluntarily choose to assume this new form of “legal personhood”, or they could remain a “legal person” in much the same way as they are today. With this proposal, however, there is one big change in the “traditional” corporation: it would not retain all of the rights and freedoms that today accrue to “legal personhood” in today’s corporate structure...making them a “limited legal person”, if you will.

To illustrate the idea more completely, imagine first how a “social conscience” corporation might work: corporate charters would have to reflect the concept that this form of corporation has a fiduciary duty to not just the shareholders, but also the corporation’s workers, and the surrounding community as well as the world environment.

The board of directors of such a corporation might have some of its seats reserved for worker representatives, and some of its seats reserved for community representatives.

A means of measurement of attained goals would be required, and one possibility would be that corporations of this type trade “conscience credits” (donate x % of corporate profit to community services and earn so many credits) in much the same way “carbon credits” are being traded today. A “conscience market” could be created that matches those who seek corporate “conscience” assistance with available corporations, and also to facilitate inter-corporate trading.

Maintaining a “no-layoff, no outsourcing” policy could earn a corporation lots of credits...as could voluntary efforts to remediate environmental damage caused by others. Investing in employee education could create credits, and you can probably imagine other incentives that we might want to develop.

Did a community offer your corporation tax incentives, and now you’re considering moving? That would be a “conscience cost”, and such a corporation would lose “conscience credits”.

A corporation of this type, in the event it possessed no credits, could be forced into “conscience bankruptcy”, where it would either have to create a “workout” plan or face liquidation, in much the same manner that corporations work through “capital bankruptcy” today.

Corporations who choose this structure would maintain all of the other legal protections afforded any person-actual or “legal”-in the American legal system.

There would be a tax incentive, as well. Profits from such a corporation would be taxed in the same manner as capital gains are treated today.

Now it’s time to flip the coin:

The officers and directors of “traditional” corporations would continue to maintain a fiduciary duty only to shareholders; and they would be free to make corporate decisions with no regard for the impact of their actions beyond that single duty, if they should choose to do so.

Here’s the cost:

--Corporate profits from this type of corporation would be taxed as ordinary income for the shareholders...and these corporations would also be taxed on “retained capital” assets (cash and cash equivalents) as well as declared “profits”.

--“Traditional” corporations would no longer have the legal status they have today. For example, they would no longer be protected under the First, Fourth, and Fifth Amendments...meaning law enforcement could conduct snap searches of corporate property...corporations would not have the free speech rights they today claim (meaning deliberate untruth itself could be criminalized)...and corporations would not be able to refuse demands by regulators to testify as to the nature of their activities (of course, the “real persons” who might have committed any illegal acts would still maintain their personal protections—but the corporation, as a “limited legal person”, could be compelled to testify against them).

This proposal envisions no change in the form or function of municipal corporations.

So that’s the idea: “traditional” corporations would be free to continue to act as they always have-with new legal restrictions and a changed tax structure.

“Social conscience” corporations would exist as well, receiving tax benefits and the full protection of the Constitution as a way to “incentivize” socially desirable behaviors.

Whaddaya think? An idea whose time has come, or more liberal hoity-toity?I’ve reported, you decide.

AUTHOR'S NOTE: this conversation began as a pair of back and forth comments between myself and Anglico over at the BlueNC site, which i encourage you to visit "early and often".

Sunday, February 10, 2008

We have an especially good story to discuss today, and it has all the elements of a Hollywood movie: an oppressive State which demands national unity from school kids on pain of imprisoning their parents, children who resist on religious grounds, a court system which than rejects the entreaties of those children at its highest levels—and angry mobs who insult, attack, and even kill those associated with the children’s cause.

And that’s just the midpoint of the tale.

Every bit of what you’ll hear today is absolutely true…it all took place in the United States during the 20th Century…and the central subject of the story, believe it or not, is the Pledge of Allegiance.

A story like this requires context, so let’s first set the stage: during the 1930s, as Hitler was growing into power…as the first stages of World War II were falling into place…many communities in the United States felt the need to inculcate patriotism into the population; and one way to do this, it was felt, was to require students to say the Pledge of Allegiance every morning.

A variety of State Legislatures passed laws putting this idea into motion, including Pennsylvania’s; a law was passed there allowing school districts to choose to make this a part of the daily ritual. Minersville, Pa.’s School District chose to do so.

You should know that the Pledge of Allegiance was a bit different than it is today.Here’s the description as provided in Justice Felix Frankfurter’s eventual Supreme Court opinion on the matter:

…The right hand is placed on the breast and the following pledge recited in unison: "I pledge allegiance to my flag, and to the Republic for which it stands; one nation indivisible, with liberty and justice for all." While the words are spoken, teachers and pupils extend their right hands in salute to the flag…

Now if any of that sounds a bit Nazi-esque to you, you’re not alone; but to address that issue is to digress, and we have bigger fish to fry.

The law stated that refusal to comply with demands to say the Pledge were to be treated as insubordination, leading to expulsion. The expulsion did not relieve the child of the burden of attending school, making violators truants. Under Pennsylvania law, parents of truants were subject to fines and jail time.

And with that, allow me to introduce William Gobitas. In 1935 10 year-old William and his 12 year-old sister Lilllian, both Jehovah’s Witnesses, refused to obey the District’s command to join the other students in the Pledge. Billy’s original letter to the Minersville School District can be seen at the Library of Congress, and it is presented here exactly as it was written:

Our School Directors Minersville, PA Dear Sirs Nov. 5, 1935

I do not salute the flag because I have promised to do the will of God. That means that I must not worship anything out of harmony with God's law. In the twentieth chapter of Exodus it is stated, "Thou shalt not make unto thee any graven image, nor bow down to them nor serve them for I the Lord they God am a jealous God visiting the iniquity of the fathers upon the children unto the third and fourth generation of them that hate me. I am a true follower of Christ. I do not salute the flag not because I do not love my country but I love my country and I love God more and I must obey His commandements.

Your pupil, Billy Gobitas

The District felt there was no need for accommodation, and the two kids were promptly expelled. The kids were eventually enrolled in private schools at the parent’s expense; lawsuits were filed all around, and in April of 1940 (roughly a year-and-a-half before Pearl Harbor) Minersville School District v. Gobitis was argued before the United States Supreme Court. (There is a difference between the spelling of the last name in Billy’s letter and the spelling as it appears in the opinion; it is reported the Court is incorrect.) A ruling followed not quite six weeks later.

The court offered no sympathy for the religious objections offered by the Gobitas children. Justice Felix Frankfurter (who would later become Chief Justice), instead, took the approach that the most important question was national unity:

…The mere possession of religious convictions which contradict the relevant concerns of a political society does not relieve the citizen from the discharge of political responsibilities… We are dealing with an interest inferior to none in the hierarchy of legal values. National unity is the basis of national security… The ultimate foundation of a free society is the binding tie of cohesive sentiment…

Beyond that, the Court questioned whether it could even competently rule on the case at all:

…But it is a very different thing for this Court to exercise censorship over the conviction of legislatures that a particular program or exercise will best promote in the minds of children who attend the common schools an attachment to the institutions of their country…

Finally, there was this:

…That the flag salute is an allowable portion of a school program for those who do not invoke conscientious scruples is surely not debatable. But for us to insist that, though the ceremony may be required, exceptional immunity must be given to dissidents... might cast doubts in the minds of the other children which would… weaken the effect of the exercise…

There was dissent on the court, and the historically notable dissenting opinion of Justice Harlan Stone is quoted below:

… The law which is thus sustained is unique in the history of Anglo-American legislation. It does more than suppress freedom of speech, and more than prohibit the free exercise of religion, which concededly are forbidden by the First Amendment and are violations of the liberty guaranteed by the Fourteenth. For, by this law, the state seeks to coerce these children to express a sentiment which, as they interpret it, they do not entertain, and which violates their deepest religious convictions…

...The very essence of the liberty which they [civil liberties] guaranty is the freedom of the individual from compulsion as to what he shall think and what he shall say, at least where the compulsion is to bear false witness to his religion. If these guaranties are to have any meaning, they must, I think, be deemed to withhold from the state any authority to compel belief or the expression of it where that expression violates religious convictions, whatever may be the legislative view of the desirability of such compulsion.

History teaches us that there have been but few infringements of personal liberty by the state which have not been justified, as they are here, in the name of righteousness and the public good, and few which have not been directed, as they are now, at politically helpless minorities…

… The very terms of the Bill of Rights preclude, it seems to me, any reconciliation of such compulsions with the constitutional guaranties by a legislative declaration that they are more important to the public welfare than the Bill of Rights…

…The Constitution expresses more than the conviction of the people that democratic processes must be preserved at all costs. It is also an expression of faith and a command that freedom of mind and spirit must be preserved, which government must obey, if it is to adhere to that justice and moderation without which no free government can exist…

In a time of growing patriotism, particularly after Pearl Harbor, public sentiment turned against the Witnesses; and there were reports of meetings being attacked by the general public, many examples of individual Witnesses being harassed…and even murders of Witnesses because of their “unpatriotic” views.

Billy and Lillian had lost, but they were not to be forgotten.

Just three years later (August 1943) the issue resurfaced in West Virginia State Board Of Education v. Barnette; and the change in attitude on the part of the Court has rarely been more dramatic in such a short period of time. Consider these quotes from the majority opinion; which overturned the law in question and ended the right of school districts to compel students to utter the Pledge:

… To sustain the compulsory flag salute we are required to say that a Bill of Rights which guards the individual's right to speak his own mind, left it open to public authorities to compel him to utter what is not in his mind…

The Court next addresses the question of how much power a democracy needs to remain viable:

… Government of limited power need not be anemic government… To enforce those rights today is not to choose weak government over strong government. It is only to adhere as a means of strength to individual freedom of mind in preference to officially disciplined uniformity for which history indicates a disappointing and disastrous end…

An additional question: is it even more important to ensure children are taught these principles of national unity than adults, justifying the School District’s legal position?

…The Fourteenth Amendment, as now applied to the States, protects the citizen against the State itself and all of its creatures -- Boards of Education not excepted…That they are educating the young for citizenship is reason for scrupulous protection of Constitutional freedoms of the individual, if we are not to strangle the free mind at its source and teach youth to discount important principles of our government as mere platitudes…

Does the Legislature even have the right to demand that those who object upon religious grounds disregard their objections in the name of the common good?

…The very purpose of a Bill of Rights was to withdraw certain subjects from the vicissitudes of political controversy, to place them beyond the reach of majorities and officials and to establish them as legal principles to be applied by the courts. One's right to life, liberty, and property, to free speech, a free press, freedom of worship and assembly, and other fundamental rights may not be submitted to vote; they depend on the outcome of no elections…

From time to time we are treated to an eloquent reminder of the bedrock notions of what it is to be American—and every one of us should take a moment to read this ruling…particularly its ending paragraphs, which should ring like a bell in the minds of those who value freedom as the core of our belief system:

… Lastly, and this is the very heart of the Gobitis opinion, it reasons that "National unity is the basis of national security,"…

… Struggles to coerce uniformity of sentiment in support of some end thought essential to their time and country have been waged by many good as well as by evil men… As first and moderate methods to attain unity have failed, those bent on its accomplishment must resort to an ever-increasing severity… Those who begin coercive elimination of dissent soon find themselves exterminating dissenters. Compulsory unification of opinion achieves only the unanimity of the graveyard…

… There is no mysticism in the American concept of the State or of the nature or origin of its authority. We set up government by consent of the governed, and the Bill of Rights denies those in power any legal opportunity to coerce that consent…

… If there is any fixed star in our constitutional constellation, it is that no official, high or petty, can prescribe what shall be orthodox in politics, nationalism, religion, or other matters of opinion, or force citizens to confess by word or act their faith therein…

So that’s pretty much our story for the day: two children who would not bow to the authority of the State caused a debate that made its way to the Supreme Court of the United States-twice-before justice was done…other members of the same religion paid with their lives for subscribing to the same beliefs…but in the end, even in the middle of a World War, with our very national survival literally at stake, freedom won a victory.

However, that’s not quite the entire story.After all, I never did tell you anything about the author of the Barnette opinion.

Justice Robert H. Jackson, who wrote the majority opinion in Barnette, has a significant history all by himself. After serving as Solicitor General (the Office of the Solicitor General defends the United States Government against lawsuit), and then Attorney General, and then a Supreme Court Justice, Justice Jackson became the lead prosecutor for the United States for the Nuremberg trials; where, in addition to designing the format for the trials (which required him to negotiate with British, French, and Soviet representatives) and selecting the staff of prosecuting attorneys, he personally cross-examined Hermann Goering and Albert Speer.

Thursday, February 7, 2008

It’s time that you and I had a little talk, my dear reader, about a subject your Mom and Dad never really explained that well. It’s gotten to a point where it is affecting your daily life, and you probably don’t even know why.

They didn’t cover it well in school, either, and if they had it likely would have just been one of those things you make jokes about later in the locker room.

That’s right…it’s time we discussed bond insurance, collateralized debt obligations…and how all of this is hitting you right in the wallet—and some comments about what’s coming next.

In other words, complicated economics, simply explained.

First things first: how does all this stuff affect your daily life?

For starters, these topics are the source of a lot of the bad economic news you’re hearing these days. If the value of your house is going down while your payments are going up…or your neighbor’s house is being foreclosed upon…or if India’s Tata Chemical Co. just bought the soda ash plant where you work…it’s already affecting your daily life.

If you invest (and that includes those of you with 401-Ks who might hope to retire someday) and you’ve been watching the Dow Jones Industrial Average (or your stock’s prices) slide downward this could be an even bigger part of your life than it is today—but as I said, I’ll explain about that before we’re done.

Trying to borrow money? This is a huge part of your life--so pay attention, and I’ll do my part to make it worth your while.

Are you an American who buys imported goods (don’t we all?), is thinking about a European vacation, or one who likes to hop over the Ambassador Bridge and spend a Saturday night out in Windsor? Notice how all those things are suddenly more expensive? This story affects you, too.

So exactly what is it we’re talking about?

All kinds of entities in “the market” have been investing in what are called “Collateralized Debt Obligations” (or other variations on a similar theme). The name seems quite esoteric, but actually it’s rather easy to understand, once it’s explained.

The way this works is you and I go out (along with thousands of our closest friends) and borrow money from our “friendly local bank” in the form of mortgages or equity loans. Our “friendly local bank” is limited in how much money they can lend—but if they can “sell” these loans to another investor they can use that money to make more loans…which means more “loan servicing” fees for the bank, and more interest money, over the long term, for all the investors.

Instead of selling one loan at a time, the loans are grouped together into “packages” of loans worth millions of dollars (the “Debt Obligation” part of the name of these “investment products”). Everyone who lends money loves collateral, and of course you can always foreclose on a house if the owner quits paying, which is where the “Collateralized” part of the name comes from.

And thus we have “Collateralized Debt Obligations”…also known as CDOs.Make more sense now?Good. Let’s forge ahead.

So who might these other investors be? For starters, names that you’ve probably been hearing in the news, such as Merrill Lynch, UBS, and Citigroup. Other countries have been putting their nation’s money to work in these investments as well—and when national treasuries invest, they usually establish what’s known as a “Sovereign Wealth Fund” (simple translation: China’s money, or Dubai’s money, or…well, you get the idea)—and China, who really needs the money at the moment, has been very active in this market.

Now if you’ve been thinking about all this you might be saying to yourself: “Self, how can people in Dubai invest in the loans we took out at the bank if they have no way of knowing which loans will get paid, and which borrowers are going to be unable to repay?”

Well, that’s where “bond insurance” comes in.

There are companies in the market (AMBAC and MBIA are the two largest players) who, for a fee, will “rate” the quality of the borrowers behind the CDO that our friendly bank is attempting to sell to an investor. Some CDOs are sent to market by banks who only lend to the most carefully-screened borrowers…and from those banks we see the “AAA” rated CDOs. Because the risk of them failing to pay is low, they pay lower interest rates (after all, risk equals reward…).

On the other hand, some of our friends and neighbors have those “adjustable-rate loans”, and there are questions as to whether they’ll be able to keep up the payments. These “subprime” borrowers (and, eventually, the CDOs their loans represent) are more risky…but they pay much higher interest rates, especially after their “teaser” rates expire—and that’s obviously more appealing to investors, if some way can be found to limit the risk.

A solution was found: AMBAC and MBIA would essentially “insure” the continued stream of income from these CDOs for a fee that would be based on the risk of repayment, as they saw it—which would theoretically make “subprime” CDOs just as safe for investors as “AAA” CDOs…only with much higher interest being paid by the borrowers to the “subprime” investors.

Low risk, big reward...it was financial genius.

And for three years or so, every time you flipped on the TV you saw ads for loans from the Countrywides and the Ditechs of the world. Washington Mutual became one of America’s largest lenders on the strength of this market.

Investors and lenders/servicers made billions in fees and interest payments with a steady stream of income ahead for as far as the eye could see—as long as the borrowers kept up the payments. Mortgage lending became a much bigger business than it had been the decade before…investing in real estate became the fast way to make a buck…and homebuilders went nutty building on any piece of land they could buy or borrow. Brokerage firms could afford to give their most valued staff the kind of bonuses that make $1000 suits too cheap to wear to work.

Condos in Florida became the investment everyone wanted to have.

But have you seen the Florida real estate market lately?

That rhetorical question is actually not a bad description of what’s happened to lots of those investors: a huge run of lending to pretty much anyone, lots of those folks can’t make their payments, and there’s so much surplus real estate out there that foreclosure isn’t resolving the investor’s problems (if you can’t sell the foreclosed property it becomes an expense as you pay some third party to maintain the place until you can…and try to imagine what happens if you own an entire condo building that’s sitting vacant—as lots of investors do).

To make matters worse, the current “glut” of real estate has depressed the value of homes and land across the country…meaning you might owe more on a property than it’s current value. (As an example, new condos in San Diego are worth much less than they were 18 months ago.)

If all that wasn’t enough, those who took out “Adjustable Rate Mortgages” (ARMs) over the past couple of years are now seeing their interest rates “adjust”—and guess what? When they adjust, the payments are not going down…they’re going up. Meaning more and more borrowers can’t pay on loans that are supposed to be long-term “safe” income streams.

Now here’s where it gets ugly for some of the players.

If you are a lender who has sold loans you become the “servicer” of those loans. That means you collect the money from the borrowers, and then pass that money to the investors…minus your fees for the service, of course. But you take a risk: as part of the “service”, if a borrower should fail to make payments, you are on the hook to keep sending money to the investor for that loan until it’s classified as “nonperforming”…which might take a few months. If many thousands-or millions-of borrowers are not paying their loans, you’ll be in big trouble—and that’s why Countrywide is in the process of being acquired by Bank of America.

Ditech is a part of the GMAC Finance operation, meaning GMAC has to cover those losses for them…and Washington Mutual, according to some observers, is today “circling the drain”; with Chase or Wells Fargo mentioned as potential acquirers.

But what if you’re one of those “insurers”? Once these loans go “nonperforming”, the potential exists for the investors who own literally trillions of dollars worth of loans to seek restitution for their lost streams of interest income—which will immediately bankrupt the insurers. If that occurs, this type of business, as we know it today, would presumably come to an end, as there would be no way to create the same low risk, high return environment investors found so attractive.

Presumably this would also remove millions of potential homeowners from the market, further lowering the demand for all that surplus real estate, and potentially bankrupting America’s homebuilders.

Of course, all these investors now have to begin the process of trying to figure out what they actually own…and how much less the true value of their investments are than what they wanted to believe. And since they are not yet sure which loans will fail…there’s no way to determine the true value of those investments. A classic Catch-22.

And that’s why you’re hearing unfamiliar terms on the news like “writeoff” and “mark to market” and “Sovereign Wealth Fund”. Investors are having to admit they have billions of dollars less in these investments than they originally thought (Citigroup has already written down over $20 billion); and some banks and brokers are being forced to turn to outside sources for capital just so they can stay in business.

It’s also part of the reason the dollar is less valuable in the eyes of the rest of the world…meaning everything we buy from another country with dollars is made more expensive—things like clothes, and cars, and HDTVs, and iPods…and oil.

That’s a reasonably good recap of what’s happened so far.

However, I also promised you a glimpse of the future.So here we go.

Most of the borrowers who took out these ARMs will see a “reset” of their interest rates 24 months after taking out their loans…and if they can’t make the new payments, the problem will become quickly evident.

There have been far fewer loans of this type written the past 18 months, which means in about 6 months most players in the market will begin to actually know just how bad their problems really are.

There are efforts to create a “bailout” for the bond insurers; but the concept there seems to be either that the investors will cover their own losses; which, from my limited perspective, seems a pointless exercise—unless some new source of investment capital can be found; or alternatively, that this function be made into a “quasi-public” corporation, not unlike Fannie Mae is today in the mortgage market.

An additional “bailout” is being considered for borrowers. Such a plan might involve not raising interest rates for some period of time on perceived risky ARMs, in order to keep the borrowers in their homes. Others have proposed a moratorium on foreclosures—but that may just be delaying the problem, not a solution.

The bottom lines of both plans seem to be that investors are going to eat some losses, either in equity or income stream—or both…and unless some lenders and investors are exceptionally patient, large numbers of borrowers are likely to lose their homes, suggesting real estate valuations will remain depressed for a few years to come—particularly in places like Las Vegas, Phoenix, Southern California…and most especially Florida, where, for a while, the run of building was most amazing indeed.

There’s an additional element to all of this that is just now becoming known.

In addition to the investors I’ve previously mentioned, we are now discovering that lots of other institutions we would never associate with the financial sector have been dipping their toes into this water; and we are now being told that states and municipalities, colleges and corporations, and various entities of all sorts have been using these investments as a way to earn money from idle cash that would otherwise have been in a Treasury bond at 3% or so.

As a result, you can expect over the next few months to hear a thousand stories about the discovery that someone or another you hadn’t thought could have will have lost money in the “subprime” market.

Having said all that, I’m here to tell you that this element of the problem is likely less of a news event-even though the effects will be more widely spread-than the problems we already are aware of in the financial sector. Why? Because the financial sector player’s losses are deep (billions of dollars each for several of those players, presumably with new discoveries through at least midyear); while this newer group of losses will likely be “shallow”—that is, lots of involved entities each losing relatively small amounts...and relatively few of them in need of “cash infusions” or bailouts to remain in business.

And now it’s time to get to the big summation:

An investment vehicle known as a CDO (and others like it) allowed banks to “sell” mortgages and other debt to a whole new pool of investors…which created a whole new pool of home buyers…which created a building boom…which led to more borrowing to cash in on that new equity…which made a ton of money for a ton of people…until the party abruptly came to an end, taking a ton of people down with it.

As a result, the Dow Jones Average is up one day, down two, banks and brokers are sweating bullets, someone in Dubai will eventually own a Florida condo complex no one wants to buy at current prices, and as many as 2,000,000 families might lose their homes.

The extent of the problem is not yet fully known, but things will be clearer by midyear; and as bad as things are now, there’s a decent chance by year’s end we’ll be getting to the other side of a great big mess.

The unexpected bonus? Now you’re ready to talk about this stuff as if it actually makes sense.